For a student, a grade of 65 percent is nothing to write home about

The airline industry has a high operating leverage. This means that fixed costs are a large part of the cost structure. The break-even volume is apparently around 65% of capacity. When the volume falls below 65%, the industry loses money. As the percentage increases above 65%, the industry becomes very profitable. There is a difference between profitability and cash flow. Since a large part of the cost structure in airlines is fixed costs, this means that depreciation makes up a large part of the expense base. Depreciation is a noncash expense. Therefore, it is likely that the industry is not profitable but has positive cash flow at capacity use that is below break-even. There is a point, however, where the industry will not generate sufficient cash to maintain operations.

The airline strategy of raising ticket prices and consolidating routes may be a successful strategy; however, there are a number of considerations. First, the higher ticket prices would increase the revenue per passenger-mile and reduce the break-even occupancy percentage only if it is assumed that there is no change in passenger volume. However, this is unlikely. The revenue from price increases would need to increase faster than the lost revenue from lower traffic volume for a price increase to lower break-even. To raise ticket prices, the airline would have to minimize the impact on lost volume. This might be possible for fare increases targeted to business travelers that need to fly anyway. The airline can minimize volume losses by keeping fares lower for nonbusiness travelers. Restrictions such as allowing reduced fares only on round-trip fares that go over a Saturday night achieve this objective, since business travelers do not wish to be out of town over the weekend. Likewise, requiring higher fares for seats reserved with little advance notice would also achieve this objective, since much business travel cannot be planned weeks in advance.

The strategy of consolidating routes attacks a major cost of airlines. The number of flights and terminals served drives fuel and airport ground- and terminal-related costs. Therefore, consolidating routes by either reducing the number of terminals served and/or the number of flights is a method of achieving some economies of scale. For example, an airline could consolidate three flights departing in the morning from Tulsa to Dallas into just two flights departing in the morning. This would reduce the airline's costs but would increase the airline passengers' inconvenience. This strategy works only if there is little loss in revenue by going to two flights, meaning that the people bumped from the third flight go to the other two, rather than a competitor. Alternatively, an airline flying into LaGuardia and Newark airports in the New York metropolitan area might decide to fly into only one of the terminals in order to reduce ground-related costs. Again, this strategy would only be successful if there was little loss in revenue relative to the cost savings.